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Book extract: selling what remains of the ‘mortgage-style loans’

November 24, 2013

Sky News is reporting that the government is planning to announce the sale of the remaining ‘mortgage-style’ loans issued to help with costs of living to those who started before 1998. Those loans have a face value of £900million but the government will be lucky to get £300m from the debt collection agency that might be willing to put up funds. 

Previous sales of tranches of those loans raised £2billion, but the government committed to offering the purchasers an annual subsidy to compensate for deferral of payment and low bank base rates until 2028. Unfortunately, they used LIBOR in the contract and still have a liability on their accounts of £250m (reflecting the value of the associated cashflows in present value terms).

A sale will lose money and only offset the bad deal entered in to last time. The key question is not the headline price pocketed by the government but that price netted against an income stream lost and any subsidy to the purchaser.

(Update, I see ‘people close to the situation’ said:  ‘The low recovery rate on the 1990s loans means the sale price is likely to be only in the tens of millions of pounds, reflecting the distressed nature of the debts’. Well done, BIS!)

Here ‘s an extract from The Great University Gamble which explains what happened last time:

In the late 1990s, in the early days of the Blair government, two
£1 billion tranches of ‘mortgage-style’ student loans were sold to third parties: Finance for Higher Education Limited, a subsidiary of NatWest, and Honours Trustee Limited, a consortium formed by Nationwide Building Society and Deutsche Bank AG. These loans were for maintenance costs only and had a fixed repayment period of five years once the very generous earnings threshold was crossed. Importantly, this made repayments more predictable than for ICR loans.

Although the full details of the sale are not public, announcements in the House of Commons at the time mean that we know that the government committed to paying an annual subsidy to the purchaser. These subsidies were expected to exceed the costs of keeping the loans on the government’s balance sheet by roughly £140 million.
That is, the government received £2 billion from the purchasers but agreed in return to pay annual subsidies that were estimated to amount to £750 million over the lifetime of the loans. Initially, about £120 million went out in the first annual subsidy but these payments diminished as the loans were repaid. In 2007, a written parliamentary answer estimated the repayments to amount to £635 million in 1998/99 terms. This was lower than originally estimated but at that stage the government had also revised down its discount rate from 6.0 per cent to 3.5 per cent. The cost was therefore revised to £125 million at that stage. …

There are a few points to pull out of this. First, the spending plans and Brown’s two rules, one Golden, were framed around headline public sector finance statistics, as the then Chancellor tried to create an approach to economic policy that was ‘open and accountable, based on clearly established rules and discipline’. Tight departmental controls for the first two years of the New Labour administration meant that the income generated from the sales helped Brown meet his ‘Golden Rule’: that income and expenditure should balance over the economic cycle.

At the time, student loans were treated very differently in the accounts: annual loan outlay was entirely classed as expenditure and graduate repayments as receipts. With the bulk of those receipts somewhere in the future, one could see the attraction of taking £2billion upfront, and thereby alleviating the short-term restraints, in return for an ongoing annual payment. The resonance with Public Finance Initiatives (PFI) also points to the rationale: the risk of loan default is translated into an annual fee which is more predictable.
Similarly, Brown’s ‘sustainable investment’ rule meant that PSND should not rise above 40 per cent of GDP. Even under different accounting conventions today, one could still see an incentive to take the borrowing used to fund the SLC (the liability) off the balance sheet, particularly as the asset, the loan book, is illiquid and therefore does not feature in the calculation around which an ‘open and accountable’ policy has been constructed.
The present government has committed to a political narrative of deficit reduction and a slowdown in the growth of PSND relative to GDP. Since loans add so much to borrowing in the short and medium term, finding a way to shift that debt off the balance sheet makes sense politically even if it is arguably economically illiterate.

Update

I’ve just realised that the second paragraph of the book extract is garbled. This following would be better

Although the full details of the sale are not public, announcements in the House of Commons at the time mean that we know that the government committed to paying an annual subsidy to the purchaser. These subsidies were expected to reduce the value of the deal so much that when compared to keeping the loans on its balance sheet, the government expected a long-run loss of roughly £140 million in present value terms.

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